Utilities ETF is the new market darling; here are some caveats

All nine S&P 500 sector ETFs joined in Thursday’s big sell-off, but the utilities ETF suffered the least as this defensive play continued its trend of outperforming this year.

The Utilities Select Sector SPDR ETF
dipped just 0.4% on Thursday to cut its 2014 gain to 9.9%, while the broad S&P 500
slid 2.1% to give it a year-to-date drop of 0.8%.

Is it time to buy XLU? Well, ETF experts have offered a couple of caveats about XLU, along with some other points:

Not leading in terms of inflows: Utilities haven\’t been a major draw for ETF investors, with XLU seeing just $479 million in inflows so far this year.

\”That actually puts them right in the middle of the pack when looking at the other sector funds,\” said David Mazza, head of ETF investment strategy at State Street Global Advisors, the giant asset manager behind the Select Sector SPDRs. XLU is well behind the energy
and health care
ETFs, which have each attracted more than $1 billion in assets in 2014 to date.

Don\’t count on continued outperformance for XLU: “It’s a good place to hide, and it’s certainly doing very well today, but it matters whether this down market continues,” said Todd Rosenbluth on Thursday. He\’s director of mutual fund and ETF research at S&P Capital IQ.

While dividend-paying utilities fare well in a flat or down market, S&P Capital IQ sees the S&P 500 eventually getting back to hitting fresh record highs, Rosenbluth said. The company\’s investing committee has a 12-month price target of 1,985 for the S&P 500, which is currently at 1,833.

Many didn\’t see XLU\’s gains coming: \”It\’s actually caught some investors by surprise,\” State Street\’s Mazza said, referring to utilities\’ strong performance so far this year. \”Most weren\’t positioned toward them to start the year.\”

A month ago, around the current bull market\’s fifth birthday, strategists gave tech
, industrials
and financials
as some sector plays likely to fare best in the next 12 months.

XLU\’s drivers this year: Rosenbluth suggested utilities have benefited from being all American. With global worries helping to spark a flight to U.S. quality, utilities \”are as domestically focused as they come\” with \”almost no non-U.S. revenue,\” he said. Consumer staples are also seen as defensive, but they\’re far more reliant on overseas revenue.

In addition, utilities — often called bond proxies — have an average dividend yield of 3.8%, and that\’s attracting investors as interest rates fall, Rosenbluth said. The benchmark 10-year yield has fallen to about 2.65% from around 3% at the start of the year.

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